The war in Iraq will take place in the heart of the world's most important oil region and will directly affect two oil-producing states: Iraq and Kuwait. That raises fears that the war could cause an immediate surge in oil prices, among other disruptions to the global oil market. In this report from Kuwait City, RFE/RL correspondent Charles Recknagel looks at the oil stakes in the coming conflict.

Kuwait City, 19 March 2003 (RFE/RL) -- With a U.S.-led attack on Iraq likely just hours away, one of the first casualties of the impending conflict has been Iraq's oil exports.

Exports under the UN-approved "oil-for-food" program all but ended two days ago as shipping insurance companies declared a moratorium on coverage for tankers visiting Iraq's Persian Gulf terminals. The UN announced its suspension of the oil-for-food program on 17 March as part of an order to evacuate all of its staff from Iraq prior to any war.

The cut-off of Iraq's legal exports -- combined with uncertainty over how long a war will last and how much the fighting may damage Iraqi oil fields -- could fuel higher oil prices as nervous traders bid for supplies to make up the shortfall. Iraq's exports under the oil-for-food program averaged 1.7 million barrels per day last month. Baghdad is also estimated to routinely smuggle some 300,000 barrels per day to Syria, Jordan, and Turkey.

Oil experts differ on how much prices may now jump. Some analysts have predicted a surge of $5 to $6 a barrel, up from this week's price of some $33. Prices at $35 to $40 a barrel would be an additional burden for industries like airlines and automakers and put further strains on the world economy, which already is suffering from a prolonged downturn.

But other analysts believe any jump could be modest. They say today's oil prices already reflect the market's worries about supplies and that the actual onset of the war -- plus prospects for a quick U.S. victory -- may now begin easing trader tension. In one sign of what might happen, oil prices dipped to their lowest level for three months yesterday after U.S. President George W. Bush gave Iraqi President Saddam Hussein 48 hours to leave the country or face invasion.

Yet oil prices are considered almost certain to jump if the war with Baghdad causes any disruption of exports from neighboring states. The most vulnerable of these is Kuwait, whose northern oil fields are close to the Iraqi border. Kuwait's southern oil fields, like the major oil fields of Saudi Arabia and Iran, are generally considered outside the zone of conflict.

Due to fears of Iraqi missile attacks, Kuwait already has closed two of its northern oil wells, losing a total of about 35,000 barrels per day. The emirate has said it will close all of its northern oil wells if necessary, even though that would reduce its national oil production by 18 percent.

Shaykh Ahmad al-Fahed al-Jaber al-Sabah, Kuwait's information minister and acting oil minister, described the emirate's policy this way to reporters earlier this week: "Kuwait will continue with its production of oil at full capacity. Now we are between 2.3 and 2.4 [million barrels per day]. We will continue with our production even if it is necessary to close our northern wells. And if we speak about [closing] those wells in the north, that means we will continue with our capacity at 1.9 million barrels per day."

The oil minister also said that Kuwait and other members of the Organization of Petroleum Exporting Countries (OPEC) will increase production to make up for any shortfalls due to war. He said the producers' goal is to keep prices at less than $35 a barrel during the crisis. "I think that with the production here and [that of] our OPEC colleagues will always be within the average of the supplies [currently] on the market, and we will make sure there will be no shortage in the market. And we even believe the prices will be stable at $35 [a barrel] and below," al-Sabah said.

Oil analysts say that OPEC members other than Iraq have about 6 million barrels per day of unused production capacity from which to make up for the loss of Iraqi or any Kuwaiti oil. Half that excess capacity is in Saudi Arabia, with most of the rest in Kuwait and the United Arab Emirates. Non-OPEC member Russia is also considered likely to increase its exports in an effort to expand its market share.

But as OPEC states reassure the market that they will dampen any price spikes, it is far from clear how the cartel will ultimately respond to the Iraq oil crisis as it continues over the next several years.

A central question is what will happen to oil prices once Iraq resumes exporting after the conflict ends. Major foreign oil companies are eager to develop Iraq's oil fields far beyond current production levels, and U.S. officials have said they count on the oil revenues to help pay for the country's reconstruction.

Yet increased production by Iraq would drive down prices unless other OPEC members cut back production to accommodate Baghdad's revenue needs. So far, OPEC has yet to give any sign of how it would solve that problem. Major drops in prices can trigger new world financial crises, such as Russia's economic setback in the late 1990s when Moscow saw its oil revenues dramatically reduced.

Abdul-Rahman al-Humood is secretary-general of the Kuwait Economic Society. He said that Iraq's oil production capacity today is some 3 million barrels per day. Baghdad's actual output has varied widely but has rarely topped 2.5 million barrels per day due to lack of equipment and spare parts during 12 years of economic sanctions. Such output compares with some 3.5 million barrels per day in 1979, before Iraq's 1980-88 war with Iran and the 1991 Gulf War.

Al-Humood estimates that Iraq's production capacity could be increased to 8 million barrels per day if foreign companies fully invest in rehabilitating and expanding the country's oil fields. He said the increase could take three to five years to realize and will face the market with the tough challenge of absorbing an almost doubling of Baghdad's oil exports.

"If we are talking the maximum with new fields and new complete maintenance to the existing fields, let's say the maximum that they reach after three years is 8 million. That means an increase of 4 million. How will the market absorb this 4 million?" Al-Humood asked.

The Kuwaiti analyst said that as the global economy grows over the next five years, increased demand could absorb about half of the new Iraqi production without disrupting oil prices. But accommodating the rest could only be done through production cutbacks and financial sacrifices by other OPEC states if prices are to remain up.

Such production cuts have never been easy for the cartel, whose members depend on their oil revenues for most or, in some cases, all of their state budgets. The past four years have seen members mostly adhere to OPEC's production-quota system in order to bring prices up from a prolonged slump. But historically, cartel members have routinely exceeded their quotas in order to earn additional revenues and take market share from rival producers.

In one measure of the difficulties OPEC may have absorbing increased Iraqi production, al-Humood voiced a widespread Kuwaiti opinion that Saudi Arabia -- OPEC's largest producer -- should bear most of the burden. He said that much of Saudi Arabia's oil-export revenue goes into private hands, so the cutbacks would not as directly reduce the state budget as they might in other countries. "Saudi Arabia has produced more than 10 million BPD [barrels per day] maybe for 12 years. But this huge amount of production does not have an effect on their economy. And the reason for this is that huge amounts of money do not go to the government budget. Let's say 20 to 30 percent of this money goes out of the budget and into the hands of the rulers, the companies, the mediators -- you name it," he said.

Such suggestions are not likely to be welcome in Riyadh, where lines between the government budget and the private budgets of top members of the royal family are often blurred. Saudi Arabia currently is running a government budget deficit and has had to postpone some development projects to expand its narrow, oil-dependent economy. That means Riyadh is likely to look for other OPEC producers with which to share any cutbacks, severely testing the cartel's ability to cope with higher Iraqi oil exports.

Iraq is a major oil player because -- despite its low production in recent years -- it has the second-largest oil reserves in the world after Saudi Arabia. Iraq's official oil reserves are estimated at 112 billion barrels, about 40 percent of Saudi Arabia's and a little bigger than those of Kuwait. Any new Iraqi government is widely expected to remain within OPEC -- of which Baghdad was a founding member -- in an effort to maintain oil producers' ability to collectively influence world oil prices.

Oil prices have been climbing since last year, when they were around $21 a barrel. Upward pressures have included oil producer Venezuela's political crisis, U.S. government purchases of oil to build up domestic strategic reserves, and Washington's showdown with Iraq.

OPEC producers have said they believe an oil price of around $25 a barrel is an acceptable balance between producers' and consumers' needs, but maintaining that target has proved difficult in recent years.